Cheap stocks may prove costly

Everything. This is the stockmarket, guys…where it is possible to lose everything. If you entered the market in September 1994, there is a 40% probability that you would have lost everything by September 1999!

Don’t believe me? Read on…

Out of the 3162 companies being traded in September 1994, only 1884 were still trading in September 1999…as many as 1278 scrips had stopped trading (vanished?). Interestingly, 1178 of these companies were trading below Rs50 in September 1994.

Share certificates can turn into wastepaper…

The picture get gory as you put the lowest Re-price segment of the 1994 era under the microscope. As many as 85 of every 100 sub-Par (shares trading below Rs10) shares turned into wastepaper by September 1999!

This ratio decreases as we move towards higher Re-price stocks. The chart above captures this trend perfectly. As we move from left to right on the graph, the stock prices increase and so do the number of stocks that are still in existence.

69% of all the shares trading between Rs10-20 in September 1994 disappeared from the market by September 1999. Things start looking up somewhat in the Rs20-50 range, with the proportion of ‘wastepaper’ coming down to 38%.

Data Used

For this analysis, all the companies which traded on September 30, 1994, have been chosen.

Prices in the month of September 1999 for these companies have been used.

The prices of the companies that did not trade even once in September 1999 are assumed as zero.

All the stock splits and bonuses have been adjusted.

On the other hand, all stocks above Rs500 survived the bear market that reigned at the Bombay Stock Exchange between 1994-1999. The survival rate was quite high in the Rs100-500 Re-price segment as well, with nearly 95% of the shares alive and kicking in September 1999.

Now let’s look at the returns

An analysis of the returns on investment over this period throws up a similar pattern, which is hardly surprising.

Returns over September 1994-99

Price Range

Positive Return

Negative Return

No. of Cos.

%

No. of Cos.

%

<= 10

17

2.34

710

97.66

10 to 20

25

2.59

940

97.41

20 to 50

47

9.79

433

90.21

50 to 100

33

8.68

347

91.32

100 to 250

65

41.67

91

58.33

250 to 500

42

26.92

114

73.08

500 +

16

22.54

55

77.46

In case of sub-Par shares, only 17 out of 392 shares provided a positive returns. On the other in 375 (about 96%) companies, investors could not recover even the principal!

The scenario worsens in the Rs10-20 category, where only 3% of the stocks gave positive returns. Even shares trading in the Rs20-50 range didn’t fare much better-only 5% of them posted positive returns. In comparison, investors who purchased stocks trading between Rs250-500 in September 1994 were better off-27% of these provided positive returns. And nearly 23% of the stocks trading over Rs 500 were in positive territory in September 1999.

Low-priced stocks: easy money…or bottomless pit?

Mahesh likes the idea of investing in low-priced stocks. His reasoning is simple. He believes that the chances of a Rs10 stock going to Rs40 are higher than that of a Rs500 stock appreciating to Rs2000. So, he feels there’s tons of money to be made in low-priced stocks. As he puts it: “Are yaar, Satasat Infotec bahut hi achha lagta hai. 7 rupye ke bhav mein kya khona-downside sirf 7 rupya hai aur upside 100% hai.”

Guess what? He’s right!

Our analysis reveals that the sub-Par (i.e. below Rs10) stocks of September 1994 which managed to survive until September 1999 actually delivered the highest returns among all categories!!

Methodology

The stocks have divided into 7 categories on the basis of their prices in September 1994, namely sub-10, 10-20. 20-50, 50-100, 100-250, 250-500, and 500+.

The percentage existence of the stocks in September 1999 has been calculated on the basis of whether they traded in that month.

Percentage returns of all stocks have been calculated over a five-year horizon (September 1994 to September 1999).

Returns of the Survivors

Price Range

Overall % Return

Traded Co. % Return

< = 10

-70.63

90.37

10 To 20

-81.31

-43
.61

20 To 50

-68.04

-48.73

50 To 100

-64.80

-58.28

100 To 250

-16.93

-12.45

250 To 500

-11.31

-8.37

500 +

-11.78

-11.78

But before you jump to any conclusions, look closer.

There are only 9 such companies in a list of 392. If Mahesh had picked any of the other 383, he would have lived to regret it. A rupee invested in that category of shares would have shrunk to 30paise in September 1999. Only 2.3% of sub-Rs10 shares doubled in the five-year period, while 85% of them vanished into thin air. Clearly, Mahesh’s chances of doubling his money were very low; he was much more likely to have lost all his money.

In other words, upside ki baat chodo, poore 7 rupye doob jaate.

Suresh’s investment strategy is in sharp contrast to Mahesh’s-he invests only in stocks that he is fundamentally attracted to. Not due to their rupee prices, but because he finds them attractively valued based on ratios such as P/e. PEG, RONW etc. Let us also assume that most of these companies traded at over Rs100 in 1994. How would he have fared over this 5-year period?

Well, Suresh would have also lost money, but he would have been better off than Mahesh. Suresh would have lost a maximum of 17% in the Rs100-250 category as and as low as 11.78% only in the above Rs500 category.

One out of every 10 stocks in the Rs100+ segment (or 57 of the 607 stocks) at least doubled over the five-year period. On the downside, 24 shares in this list disappeared altogether. Therefore, if he had picked his stocks wisely, Suresh had a better chance of doubling his money.

You get the drift, right?

Well, you’ll agree with me now when I say that you can lose everything in the stockmarket.

So, what is the best way to avoid to this? That should also be clear after the above analysis. Look for companies with sound fundamentals. And focus on returns-whether the stock has a low Re-price or a high Re-price is immaterial.

Let us learn from the past and start channeling our money in the right direction. Happy investing.

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About Rajandran

Rajandran is a Full time trader and founder of Marketcalls, hugely interested in building timing models, algos , discretionary trading concepts and Trading Sentimental analysis. He now instructs users all over the world, from experienced traders ,professional traders to individual traders.

Rajandran attended college in the Chennai where he earned a BE in Electronics and Communications. Rajandran has a broad understanding of trading softwares like Amibroker, Ninjatrader, Esignal, Metastock, Motivewave, Market Analyst(Optuma),Metatrader,Tradingivew,Python and understands individual needs of traders and investors utilizing a wide range of methodologies.

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